Streaming's Poised to Save the Music Business. Now Apple's Ready to Take Over

Global revenue from recorded music has halved from nearly $30 billion before leveling off to about $15 billion in the past few years. In the United States, recorded-music revenue suffered a similar free fall, cratering in 2011 at $4.5 billion before mildly recovering to $4.9 billion last year.

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Now for the first time since its Napster-induced cliff dive, the industry is poised to grow faster than the national economy, at greater than 8 percent, according to New York's New Music Seminar. Factor in the lower overhead implicit in digital delivery and this means far greater profitability.

Give streaming, notably Spotify, credit for the explosive anticipated growth. It debuted in America four summers ago and started taking off 18 months ago. In just the past year, it has grown worldwide from 40 million to 75 million active users and doubled its paid subscriber base from 10 million to 20 million.

Spotify's biggest global competitor, Deezer, recently bought AT&T's Muve music-streaming service with its 2 million U.S. subscribers. By year's end, Google is expected to debut its MusicKey paid service, built around YouTube and paired with its present streaming offering, Google Play. Meanwhile, Spotify announced in May that it will add video.

Others seem to join the fray each month. After selling his Beats to Apple, music mogul Jay Z teamed with other big-name musicians in the artist-friendly Tidal service. Clear Channel Radio (with its new branding as iHeartRadio) also has its own streaming service. Even Facebook is working to create a video-streaming platform.

Apple's absence has been notable, if understandable. (Apple declined to comment for this article.) It feared a streaming service would cannibalize its download business, which controls two-thirds of the world market. Ultimately, it realized this would happen anyway, opening the door for Apple Music.

Apple arrives not as an innovator set to save music and revitalize itself as a lifestyle product. It is jumping aboard an emerging industry. Yet the company's arrival is crucial because it signals that streaming has become a mainstream phenomenon — which probably is what Apple was waiting for.

"[Apple has] developed a very mainstream customer base, and mainstream consumers aren't early adopters. Mainstream consumers do things much more slowly than most people — so they have to innovate at a pace that is appropriate to those users," says industry analyst Mark Mulligan of MIDiA Research. "What Apple does is make products ready for prime time. They don't climb in new markets; they make markets by making it elegantly simple for less-savvy consumers."

With a captive audience of more than 250 million iPhone and 800 million iTunes users, Apple's reach is unprecedented. When Apple's free three-month teaser memberships run out after this month, the music industry will arrive at a crossroads:

Is the product enticing enough to motivate people to pay for what they can get free? And if they won't, what does this mean for musicians?

"When the CD came out — boom — the digital genie was out of the bottle, and there was no putting it back," says Tempe musician Roger Clyne of the Peacemakers. "Streaming is here, and there is no putting it back. It's just . . . how are we going to make this system the fairest it can be?"

Streaming’s here to stay, Roger Clyne says, adding that the big question is how to make it fair to musicians.

Jim Louvau

From the moment he experienced Rhapsody, the first music-streaming service to debut in late 2001, industry analyst Mark Mulligan was sold. Thirty million tracks available at the push of a button seemed like a killer app to him and his analyst colleagues.

"We were converts and thought the digital music market will be all about streaming by 2007 or 2008," he says, laughing. "We got it right but were completely wrong in terms of timing."

Instead, downloads took off and stayed strong, held aloft in part by Apple's control of the market. When the industry allowed Apple to protect tracks with its own digital rights management protocol, it effectively cordoned off the market. For years, only Apple devices could decode its DRMs, handcuffing people to the company's devices and to its iTunes store.

"The download markets were so strong and so hard to break into because the vast majority of people who paid for digital music were — and to some degree still are — Apple customers, and Apple had them all locked behind a huge wall," Mulligan says. "Then, Apple launched its app store, opening the door into its castle, and suddenly everybody could get in.

"That's why Spotify was able to build a business," he says. "Suddenly, other people could sell music products directly to Apple customers. That was the inflection point."

Several factors also had to coalesce for streaming to fully take off — bandwidth increased and got cheaper, smartphones grew ubiquitous, and consumers became more familiar with streaming and its social aspects.

Spotify came along and gave away music on a free, ad-supported tier in the hope of converting listeners to a paid tier. A little more than a quarter of its free users have upgraded to paid subscriptions.

It made an equity deal with music labels (rumored to be as much as a collective 20 percent stake), buying time for the plan to work. Labels could realize a tidy profit from a strong Spotify IPO, giving the labels an incentive their artists don't have.

The result is a one-third industry boost in paid streaming subscriptions last year, with the possibility of the increase tripling or even quadrupling (to surpass Sirius/XM Radio's 28 million users), depending on the success of Apple Music.

These days, streaming and vinyl are the only growing parts of the industry — downloads and CD sales have continued to fall, albeit at a much slower pace.

It is interesting that some of Spotify's label contracts are said to be expiring in October, around the time that Apple's three-month trials convert to paid subscriptions. It is easy to imagine a strong showing by Apple Music, putting increased pressure on Spotify. Early figures have 11 million users signing up for the trial. Apple's potential success ultimately will lead, many experts say, to some limits on what is available at no charge.

"The amount of value being given away to the consumer at whatever price to Spotify will be extraordinarily pared back if you believe what the CEOs of all the major record labels are saying," says Ethan Rudin, Rhapsody chief financial officer and head of label relations.

Of course, as shareholders, these CEOs won't want to do anything rash.

"If they were to pull the rug out from under those rights, [they would be] damaging the value of their investment," says Rudin, who previously worked on Wall Street. "But you definitely do see some movement away from full, free, on-demand streaming."

Maynard James Keenan feels free music diminishes the artist.

Cherie Roberts

Musicians are doing their part to limit free's appeal.

Artists such as the Black Keys, Taylor Swift, Bjork, and Tool have kept or taken their catalogs off Spotify because they say it devalues musicians' work. Selling CDs for below cost at Best Buy was one thing, but giving away music to all comers is something entirely different, even if streaming has been an essential step in neutering piracy.

"BitTorrent to free YouTube? I don't know if that's an advance. I think it's maybe a symptom of a bigger problem," says Tool/Puscifer frontman and Arizona resident Maynard James Keenan. "If things come to you for free, you just inherently don't have respect for what went into them. It can be pretty daunting after all the effort that is made to make this music."

As Keenan notes, Spotify isn't the only perpetrator.

YouTube has become the greatest global resource for new music, its viral charms minting stars by the dozens (from Lana Del Rey to Justin Bieber and Soulja Boy). It's expected to average 8 billion views a day by the end of the year. YouTube is to young people what radio was to the American Graffiti generation, a free and ubiquitous source of entertainment.

The difference between YouTube and Spotify is that YouTube doesn't pay royalties. Spotify finances all its streams on the paid and ad-supported levels, but at diffe

rent rates because there isn't much ad revenue. (Last year, 91 percent of the company's revenue came from paid subscriptions.)

Though YouTube doesn't distribute royalties, it has paid more than $1 billion from advertising revenue to rights holders over the past several years. YouTube parent Google is in the process of making the video hub part of a new music service, Music Key, that will merge YouTube into its current streaming offering, Google Play Music.

Rhapsody, like Apple, never offered a free tier (though it nearly has matched Apple Music by offering a three-month trial for $1). The company's growth has been slow, steady, and sustainable, though it benefited from the greater cultural awareness and acceptance afforded streaming because of Spotify.

"At any one time in the company's history, we could've decided that we wanted to go raise the same amount of money Spotify did, strike those same deals with the record companies, and train consumers that music is free," Rudin says. "That is not what we stand for, and that is not what we represent."

Last November, when Taylor Swift pulled her catalog off Spotify, she called the company a "grand experiment . . . that I don't feel fairly compensates the writers, producers, artists, and creators of this music." Prince and Garth Brooks are among other artists who pulled their music from streaming sites to protest the low rates, which range from $0.006 to $.0084 per stream.

But they may be blaming the wrong people.

Last month, Berklee College of Music's Rethink Music initiative released a report on transparency in the music industry. It suggested that at least one in five royalty payments fails to reach the proper rights holder. (There is a variety of different royalty rates for songwriters and performers, depending on the medium.)

This unclaimed money ultimately is split among labels based on market share, even though the money more likely is owed to smaller companies representing lesser-known independent artists.

The lack of transparency ensures that the true scope of the problem is difficult to determine. Similarly, decoding lengthy royalty statements is difficult to impossible. What is clear, according to the report, is that the system's as opaque as National Security Agency surveillance, with the weight falling on artists.

"I think it's purposefully set up to be a befuddling if not completely [unworkable] exercise," Roger Clyne says. "It seems like almost a foregone stratagem that artists aren't going to be able to disentangle this stuff so they'll move along. They aren't going to have the time to stop this train."

Some royalty issues lie in label contracts, with charges and rates descended from when music primarily was a physical product. Maybe it made sense (or was at least defensible) to give an artist $3 for each $18 compact disc when there were so many middlemen — pressing plants, shippers, distributors, stores — getting their slices.

Artists such as Clyne now ask, what is the labels' excuse now that the overhead's close to zero?

"Now that you're not in a physical product environment anymore, does it make sense for the artist to be getting a royalty rate of 13 percent to 22 percent minus the deductions," asks Allen Bargfrede, a former musician manager, professor, and founder/executive director of Rethink Music. "Because [the labels] not only pay the low royalty rates but all of the costs [such as marketing and tour support] are charged back [to the artist] against that ridiculously low royalty rate."

Competing with free forced artists to up their game. Greater effort had to be made to cultivate fans and entice them to spend money on physical product. This meant special packaging, additional live DVDs or b-sides, discs, and memorabilia.

"Value-added," it was called.

"I remember the days by the tour bus when people would come up to me with a ripped CD and ask me to sign it," Clyne says. "And I remember the 'value-added' conversations."

Clyne and the Peacemakers decamped to Rocky Point, Mexico, where they broadcast their writing/recording process over eight days and took feedback from fans. This level of engagement was repaid with the kind of steadfast fans who think nothing of funding a band's Kickstarter campaign or traveling a hundred miles to see a group play.

From an overall perspective, giving away music has worked — more people than ever have become music fans. Now, thanks to streaming and speaker technology, it's possible to have your music follow you from room to room and right into your car without lifting a finger.

As radio is going the way of the dinosaur and eight-track tape, better forms of listener engagement are emerging to amplify audience interest. Though they have burned down half of the traditional music industry, more personalized possibilities are sprouting — such as curated playlists and computer-offered musical suggestions.

"I'm excited about the delivery system because I love when new music is suggested to me," Clyne says. "Big Brother is looking over my shoulder, but he recommends the new Rhett Miller album. I didn't know about it, but he figured out that I should. I can't say I didn't enjoy it."

In 30 years, music consumers have evolved from passively listening to whatever radio gives them to taking some of their music with them (Walkman) to taking their entire collection with them (iPod) to having access to the most readily available recorded music with custom recommendations and curated playlists (smartphone).

"The engagement with music has gone through the roof," says Tommy Silverman, founder of Tommy Boy Records and the annual New Music Seminar. "People are engaging in music at every level in the live world and in the recorded-music world at [degrees] that are unprecedented. We just hadn't been able to monetize it."

Some worry that as long as there is a free option, freeloaders will dominate and subscriptions won't gain steam. In a speech this year, Universal Music chairman Lucian Grainge said free, ad-supported music isn't "particularly sustainable in the long term."

Sony music head Doug Morris shares Grainge's skepticism about Spotify's ad-supported tier, but Morris is bullish on streaming's overall effect on the music industry — because it's projected that more than 15 million Americans will spend at least $120 each on streaming subscriptions this year.

Tommy Boy Records’ Tommy Silverman says, since streaming, engagement in music has never been higher.

In 1999, at the height of the traditional music business, the average music consumer spent $71 a year.

"I do think this change to streaming signifies a tipping point in the music industry. The [recorded-music business] has halved in the last 10 years," he says. "I think this tipping point will bring it back to where it was before. [Spotify's home country] Sweden is back to where it was 10 years ago. My guess is that, slowly, Europe and the U.S. will go the same way, and we will have an industry that is healthy, robust, and powerful."

Spotify maintains that it will "stay the course." In a May financial statement announcing $180 million in losses for 2014, the company said its subscription-only model had not yet "proven a path to profitability."

The pioneer streaming firm is geared to always pay about 70 percent of its revenue to rights holders. But it's presumed that the company's overhead is relatively fixed, meaning as its subscriber base grows (and, by extension, its number of paid subscriptions), so will the value of the remaining 30 percent.

Similarly, if and when the number of paid subscribers triples/quadruples/quintuples, so will payouts to artists, to some degree alleviating musicians' worries.

Warner Music Group's Stephen Cooper sounded hugely upbeat during a May earnings call, which featured news that streaming had surpassed downloading in first-quarter revenue.

"The rate of this growth has made it abundantly clear to us that in years to come, streaming will be the way that most people enjoy music," he said. "Not only that, we are also confident that streaming's ongoing expansion will return the industry to sustainable, long-term growth."

Cooper suggested that this very success is reason for pause before targeting Spotify and YouTube's free offerings.

"With respect to going to a strictly subscription world, I think that you can find evidence that when music is not generally available, people will seek out sites on the Internet that will offer up that music for no charge," he says. "Before people conclude that 'freemium' should be burnt at the stake, we should think very carefully about the consequences."

Another point in Spotify's favor is that it is purely about music. Though that is the case for most first-generation streaming companies — including Pandora, Rhapsody, Rdio, and Deezer — the latest entrants are broadcast radio empires, Internet search and retailing giants, and makers of lifestyle devices.

For these latecomers, music is just something else to sell.

It's because of Apple Music, of course, that so many are talking about what industry insiders call "freemium."

It's an enticement that a smaller company like Spotify can offer in lieu of the extensive ad campaigns that accompanied Apple's iPod and iPad. In April, the firm's valuation reached $1 trillion, close to 70 times the size of the global music industry's worth. For Apple, music practically is the lighter sold at the convenience-store register.

While lots of companies are getting into streaming, their long-term profitability is questionable. Rhapsody has had 14 years to cultivate its user base, but the smaller, newer entrants could have shorter shelf lives because of high up-front costs.

Contracts revealed by this year's hack of Sony's computer system show that Spotify paid $42.5 million up front just for access to the label's music, not counting royalties.

"There's quite a moat for people to jump to get into this business . . . but whether they can swim remains to be seen," Rhapsody's Rudin says. "We're rooting for everyone because we truly believe that a rising tide [will float] all ships."

That's easy for Rudin to say, since Spotify's success and streaming's sudden popularity have had a positive effect on Rhapsody's bottom line.

An obstacle — though not an impenetrable one — to Apple's again becoming a dominant force in the industry is a Federal Trade Commission probe that began in July.

The FTC is investigating the 30 percent markup Apple charges consumers to download other streaming services' apps. So those who download Spotify from the iTunes Store pay $12.99 monthly rather than the $9.99 consumers pay if they sign up directly with Spotify.

Plus, the store's rules deny competitors the right to notify consumers that they could get Spotify cheaper by going straight to the source. Apple has so much of the smartphone market that competitors feel they have little choice but to comply. Now that Apple's created its own streaming service, the conflict of interest appears even more egregious, which sparked the FTC attention.

Apple already tried to get away without paying royalties during Apple Music's free trial. It would've succeeded, too, if Taylor Swift hadn't foiled its plans with her public complaints. (Apple eventually agreed to pay a lower-than-usual streaming royalty rate during the trial period.)

A more dramatic transformation is under way now than even when Napster emerged.

Its peer-to-peer network software operated a lot like the iTunes Store, minus the payment option. Consumers downloaded tracks and took possession of them.

Streaming forges a fundamentally different relationship.

Rather than retailing replicas, it provides a pass to the museum. The industry is moving from hawking ownership to offering unprecedented access — access that's far more satisfying than what FM radio and MTV provide.

When Bjork released Vulnicura earlier this year, she told Rolling Stone that free streaming was "just insane" and wondered aloud why the music industry can't replicate the video-streaming company Netflix: First a movie appears in a theater, and then it goes to Netflix.

Though movies are different (for starters, they engage audiences for far longer periods of time than songs), many have echoed Bjork's thinking — that it makes sense for music to come out physically at first, shortly thereafter on paid streaming sites, and finally on free sites like Pandora and Spotify's no-charge tier.

This way, artists could move music behind a subscription wall without limiting the material altogether.

"If you want to have the best music first, you need to pay for it," Mulligan says. "This, in principle, sounds very straightforward and logical, but it's actually fraught with complications."

Perhaps the biggest one is that various facets of the industry have difficulty agreeing on anything, no matter how logical or beneficial it may be to the industry as a whole. For example, until earlier this summer, every new piece of music was released on different days of the week around the world — which may have made sense when music needed to be shipped physically, but the industry has been in a head-first digital plunge since at least the millennium.

Why should German music lovers, for instance, wait a few more days for new American music? This only encourages piracy, as foreign listeners turn to BitTorrent rather than wait for the official release date.

What is needed now, industry analysts say, is for labels and streaming services to agree at least on how to administer new music with different release windows — like the movie business does with its motion pictures.

But streaming services grumble because they pay dearly for exclusive rights to inventories.

"You would think that the music business would be able to follow the movie business to protect itself," Rudin says, because when streaming is at full force, a system like the movie business' would engender more money for everybody.

"There is certainly a case for [release windows], but it won't exactly be the same as movies because movie-release windows are protected in so many ways that music can't be, certainly so long as you have [free]YouTube in the equation," Mulligan says.

Says Tool's Keenan: "Look, people are going out of their way to pay for the HD version of things. How the fuck does that not translate to music?"

In other words, consumers will pay for getting music first through a convenient and superior system.

One thing is certain: The public's thirst for music remains unquenched.

To satisfy it and thrive, many experts believe, the music industry must figure out a way to retain the allure of free while securing enough premium content behind pay walls to ensure that free doesn't become the fact of life that piracy once was.

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Ideally, experts say, this is accomplished without letting Apple attain a scope that allows it to dictate terms to a music industry that it could purchase many times over — and with release windows that preserve the value of purchasing music before anyone else hears it.

"We have to do the math to identify how we tune the ecosystem to maximize money for artists and labels," Tommy Boy Records' Silverman says. "It's a work in progress, but it's moving in the right direction. I think there's going to be some ecosystem correction that happens toward the second half of next year."